May 15, 2024

Distressed Acquisitions: Buying Creditors’ Claims to Obtain Control

Wachtell recently published the 2024 edition of its “Guide to Distressed Investing, Mergers & Acquisitions.”  This 230-page publication provides an in-depth review of the legal and process issues associated with acquiring or investing in distressed companies both in and out of bankruptcy proceedings.  Here’s an excerpt from the Guide’s discussion of buying claims as a strategy for gaining control of a distressed company:

An investor seeking to acquire a controlling stake in a reorganized debtor generally will want to accumulate the so-called “fulcrum” security—i.e., the most junior class of claims or interests that is not entirely “out of the money” and is therefore entitled to the debtor’s residual value. When a debtor has adequate collateral to refinance or reinstate all of its secured debt, the fulcrum security is likely to be the unsecured debt.

In contrast, when a debtor can reinstate or repay its first-lien lenders, but not lenders with junior liens, the company’s second- or even third-lien debt will be the fulcrum security. And in situations where a debtor is solvent, prepetition equity interests are the fulcrum security. Regardless of which security is ultimately at the fulcrum, its holders are in a position to control a reorganized debtor if that security is converted into a significant portion of the new equity.

There are also several reasons why it may be beneficial for an investor seeking control to accumulate claims or interests other than just the fulcrum security. For one, the ability to ensure confirmation (or rejection) of a plan generally depends on the tally of votes of various classes. To influence the process, it can be beneficial to hold large positions in other classes in addition to the one that holds the fulcrum security.

The guide also covers out-of-court workouts & acquisitions, pre-packaged and pre-negotiated plans of reorganization, Section 363 acquisitions and acquisitions through the conventional plan process.

John Jenkins